Emerging market equities make up an important part of my investments. They’ve offered investors some exceptional returns over the long term, all be it at higher volatility. For the past few years the asset class has struggled, however, as money has flown back to the developed world after the US began tapering its quantitative easing programme. It has done better recently; whilst the UK stock market has been almost flat for the year, emerging markets have returned 10.73% year to date.*
When it comes to choosing emerging markets funds investors have two options. The simplest is to choose a global emerging markets fund which covers emerging markets around the world. The alternative is to choose a range of funds with exposure to different emerging countries or regions. The trouble with the latter option is it can be tough to manage.
My reason for writing this article is that it has become increasingly difficult to buy a good global emerging market fund. In fact only one fund, the M&G Global Emerging Markets fund, is currently on our Chelsea Core Selection or Selection.
Global emerging markets is a tricky area for fund providers because it requires a lot of infrastructure and analysts. With less broker coverage, funds need boots on the ground to do their own research and not every fund provider has the resources. This is partly why emerging markets funds are often slightly more expensive.
Frustratingly, many of the best emerging markets funds are now closed to new investors. Four of the five top-performing emerging markets funds over the past five years are now hard or soft closed. In the smaller company space the Aberdeen Global Emerging Markets Smaller Companies fund, which has performed exceptionally well, is also closed.
Closed Emerging Markets Funds:
Aberdeen Emerging Markets
Aberdeen Global Emerging Markets Smaller Companies
First State Global Emerging Markets Leaders
First State Global Emerging Markets
First State Global Emerging Markets Sustainability
Samsung and Taiwan Semiconductor
Of the 10 top-performing funds of the past 10 years all of them barring the closed First State funds (which came 2nd and 3rdin terms of performance) currently hold Samsung and Taiwan Semiconductor in their top three holdings. The multi-national Hyundai was also owned by five of the top 10 funds. An investor could just as easily gain exposure to these stocks through a cheaper passive fund.
Do all these top managers really all have these two stocks as their best ideas? Samsung based in Korea, is not even in a country which many would consider to be an emerging market, although the company has interests around the globe. I have always believed in a contrarian philosophy when it comes to investing. Historically, the best managers have made money by being different from the crowd. There isn't much choice for investors when every fund holds the same stock.
As an advocate of active funds I find this situation depressing. If I pay for an active manager I want them to do something different. It is perhaps unsurprising that only six funds beat the MSCI Emerging Markets over 10 years. Of these, four were closed in some form until recently and one beat the index by just 1%. The one remaining fund was the Baillie Gifford Emerging Markets Growth fund. This is disappointing as emerging markets should be an area where active managers can thrive - there is often less coverage and information in the market, particularly on smaller stocks.
What Can an Investor Do?
Luckily there are options for investors. The Lazard Emerging Markets fund has recently reopened to new investors, after having previously been closed since November 2010. The fund, run by James Donald was previously on the Chelsea Selection before its closure. It does currently hold Samsung and Taiwan Semi-Conductors in its top three holdings but it is one of the few funds I mentioned above which has beaten its benchmark by a comfortable margin over the past ten years. It was also recently awarded an Elite Rating by the FundCalibre ratings agency.
Another option is the Schroder Small Cap Discovery fund. A relatively new fund, it was launched in 2012 and is co-managed by Matthew Dobbs and Richard Sennit. Both are experienced managers with strong track records who have been awarded an Elite Rating from FundCalibre. Matthew also runs the Schroder Asian Alpha Plus fund and Richard the Schroder Asian Income fund. This fund will appeal to investors looking to get away from the traditional large-cap bias of many emerging market funds. As you would expect it has a heavy Asia-Pacific bias, given the managers backgrounds, but it does make investments all around the world. The fund benefits from Schroders global presence and vast resources. It has got off to an incredibly strong start, returning 34.58% since it launched.
The M&G Global Emerging Markets fund, which has more of a mid-cap bias, also remains on the Chelsea Selection and has an Elite Rating. For those who want income the JPM Emerging Markets Income funds is also on the Chelsea Selection.
As I mentioned before, if you have the time, you can also build an emerging portfolio by investing in specific regions. The following funds are also on the Chelsea Selection:
Fidelity Emerging Europe Middle East & Asia, Fidelity Latin America, Invesco Perpetual Hong Kong & China, JPM New Europe and Neptune Russia & Greater Russia.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. James' views are his own and do not constitute financial advice.
*Source FE Analytics MSCI Emerging Markets 29/08/2014